'I’m happy to accept a higher risk for a higher return': How peer-to-peer Isas lend edge to investing

People who lend money to strangers or unheard-of businesses are contributing to a sector of the economy that grew by 84 per cent last year to £3.2billion.

This is according to a report by the University of Cambridge and charity Nesta, which analyses the rise of ‘alternative finance’, including peer-to-peer and crowdfunding websites.

Demand is unlikely to dampen any time soon as new rules to be introduced in five weeks’ time will allow investors to shelter some of their profits in a tax-friendly Isa.

In Crowd: Louisa Stockley uses the Crowdstacker website to invest

Peer-to-peer websites match cash-rich savers with people or businesses who want to borrow money, with better or decent rates all round.

Growth in this market has accelerated as traditional savings accounts continue to pay paltry interest rates. Enthusiasm for crowdfunding – the means of investing in a business in return for a share of the company – remains keen.

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'I’m happy to accept a higher risk if the return is bigger'

Louisa Stockley dipped a portion of her personal savings into the peer-to-peer market recently via the Crowdstacker website – complementing her existing pension and Isas.

The 36-year-old digital marketing consultant – who is married with two young children and lives in Thame, Oxfordshire – plans to move her investment into a peer-to-peer Isa in April, which Crowdstacker can offer straight away as it has full authorisation from regulators.

Currently she has loaned funds over a three-year term to property company Quanta Group, with expected annual returns of 6.8 per cent. On the question of risk Louisa says: ‘I think if an organisation offers anything more than 4 or 5 per cent interest it is going to come with an element of risk. I’m happy to accept a slightly higher risk for a higher return.’

She adds: ‘The rule is to not put all your eggs in one basket and research which peer-to-peer platform you choose. You want one that does its homework and only offers loans to people or firms that are financially sound.’

Peer-to-peer – or ‘innovative finance’ – Isas will be available from April 6, the start of the new tax year. Investments into equity-based crowdfunding will not be permitted within an Isa.

Not all websites will be geared up in time. Key companies, such as Zopa, RateSetter and FundingCircle, are still awaiting full authorisation from the Financial Conduct Authority, the City regulator, which they need before they can offer an Isa.

Supervision of peer-to-peer companies was passed from the Office of Fair Trading to the FCA in April 2014, when they were given a kind of temporary pass – known as interim permission – to carry on their business until full authorisation is secured.

Andrew Lawson, Zopa’s chief product officer, says: ‘We’re working with the regulator to secure our full permission, which we expect to receive in the coming weeks. We can then apply to Revenue & Customs for Isa manager status, which usually takes less than two weeks.’

Some providers already have full authorisation, such as Crowdstacker. Karteek Patel, chief executive, says: ‘It may be that some platforms miss out on the chance to offer the new Isa as soon as it comes into being. But, ultimately, taking the necessary time to obtain authorisation will be in the best interest of the consumer.’

TAX RULES

Investors can save up to £15,240 in an Isa from the beginning of the new tax year starting April 6. Contributions can be spread across one cash Isa, a stocks and shares Isa and an innovative finance Isa. Or the lot can go into just one account. Since many customers invest with more than one peer-to-peer website, they can only pick one provider to build an innovative finance Isa.

Patel says: ‘As the innovative finance Isa develops, the industry will need to find ways to offer investors the ability to spread their tax-friendly investment across several platforms rather than just one.’

Investors can still lend through multiple websites but tax will apply to income earned from the non-Isa accounts. A new personal savings allowance will be introduced in April that scraps tax on the first £1,000 of savings interest for basic rate taxpayers. Higher rate taxpayers will get a £500 allowance, while those paying the top rate of income tax at 45 per cent will get nothing.

As a result, many peer-to-peer lenders will see their returns build free of tax anyway.

WARNINGS

Lord Turner, former chairman of the Financial Services Authority until it was replaced by the FCA in April 2013, recently predicted that peer-to-peer would be the source of ‘big losses’ in the future. Losses, he said, that would make ‘the worst bankers look like lending geniuses’.

His comments sparked indignation from professionals in the sector. Christine Farnish, chair of P2PFA, the association representing peer-to-peer operators, says: ‘Since the industry began, defaults on loans have been low, measuring between 2 and 3 per cent.’

Market growth: The advertising campaign for peer-to-peer lender Zopa

REGULATION AND RISK

Peer-to-peer and crowdfunding companies are authorised by the Financial Conduct Authority which means their businesses come under close scrutiny. But that is not to say that customers can never lose out.

Money loaned out this way is not covered under the Government-backed Financial Services Compensation Scheme. This scheme guarantees the first £75,000 of an individual’s cash savings with each separate bank or building society.

Investing in early stage businesses via crowdfunding is riskier due to high business failure rates. With peer-to-peer, the risk is whether or not people are likely to repay their loans. But customers are credit-checked and most websites have developed ways of mitigating risk. Loans are often spread across a number of borrowers and cash is kept in reserve to refund lenders if a borrower defaults.

Not all crowdfunding comes under the scope of the regulator – equity based does, rewards or charity based does not – so there is arguably more risk in this part of the market.

NEW PRODUCTS

From the middle of next month Zopa will launch three new deals.

Its ‘access’ account will offer annual returns of between three and four per cent with no fee levied if quick access to cash is needed. The ‘classic’ account has a higher expected rate of up to five per cent – but a one per cent fee if a borrower wants out.

Both access and classic are covered by the ‘safeguard’ option – a pot of money that can be used to repay lenders if a borrower fails to. The third account, ‘Plus’, is not covered by safeguard but will offer a return of up to seven per cent after expected defaults. A one per cent fee will be imposed if a borrower wants out. All three accounts will be eligible for Isa status once Zopa receives authorisation from the regulator.